2. Why Costing?
Cost decisions and the model/system
will influence the achieved results
– which will have dire consequences
Anyone can get a Sale at a suicide price!
So you have to know what that price is!
3. What is Cost?
Cost accounting is full of:
estimates,
guesses,
standards and
depends upon amounts that are not the actual cost
Many say that Cost accounting makes a guess and
then accounts for the difference from actual as a
variance
4. Cost – an ideal world!
If cost remains static – without inventory
Buy 10 @ $200 $ 2,000
Sell 7 @ cost = $200 1,400
Ending quantity 600
5. Cost – an ideal world!
If cost remains static – with inventory
Start 3 @$200 $ 600
Buy 10 @ $200 2,000
Available for sale 2,600
Sell 5 @ cost = $200 1,000
Ending quantity 1,600
6. Cost – Rising price
If cost remains static – with inventory (FIFO)
Start 3 @ $200 $ 600
Buy 10 @ $220 2,200
Available for sale 2,800
Sell 3 @ cost ($200) 600
Sell 2 @ cost ($220) 440 1,040
Ending quantity (8) @ $220 1,760
7. Cost – Rising price
If cost remains static – with inventory (LIFO)
Start 3 @$200 $ 600
Buy 10 @ $220 2,200
Available for sale 2,800
Sell 5 @ cost ($220) 1,100
Ending quantity (3) @ 200 600
(5) @ 220 1,100 1,700
8. Cost – Standard
If cost remains static – with inventory (Standard Cost)
Start 3 @$200 $ 600
Buy 10 @ $200 (Variance=$20 each) 2,000
Available for sale 2,600
Sell 5 @ cost ($200) 1,000
Ending quantity (8) @ 200 1,600
If price went up to $220 >>
Price variance = $200 (10 x $20)
10. Cost Accounting System
Purpose of the Variance is to highlight the difference:
Planned amount
Actual amount
We need to know if our quote was too low (because
cost price is higher than we used)
Or if the quantity was planned wrongly
(more was needed = (underestimated) or
alternately was over-estimated)
11. Cost Accounting System
When using Standard Costs we are assuming
the norm (Standard)
- everything should go according to plan!
Good luck with that!
12. Cost Accounting - decisions
Costing Type
- Traditional historical - Normalized historical - Standard
Inventory Costing Method
- FIFO - LIFO - Average - Specific
Costing Method
- Job - Process - Activity
Interval
- Period - Perpetual
14. Cost Accounting System
A Variance account contains the differences from
standard
This is information that is basis for decisions
It MUST be analyzed to get to the information
EG: Materials Variance can be:
1. Price variance
2. Quantity variance
15. Normal Cost Accounting
Account
Dr Cr
Inventory
Actual Raw Materials
Actual Labor
Allocation of Overhead costs
Account
Dr Cr
Variance
21. Standard Costing
Quotation >> Job/Batch Production Order
Number of processes (Job/Px)
Each process has:
a) RM input
b) Labor budget
- Operation (Direct)
- Operation (Indirect)
- Admin/Manuf
c) O/H allocated - Manuf
- Admin
23. Standard Cost Accounting
Account
Dr Cr
Inventory
Actual Raw Materials
Actual Labor
Actual Overhead costs
Account
Dr Cr
O/H Variance
Account
Dr Cr
Account
Dr Cr
R/M Variance
Labor Variance
25. ABC – Activity Based Costing
The ABC approach allocates a cost of a facility according to the
capacity – which is the divisor in the equation. Thus the idle capacity
is not charged to the product but remains as an idle capacity variance.
EG: If the plant is operating at 60% planned capacity – is it ‘fair’ to
allocate 100% of the cost?
Answer is NO – the spare (unutilized) capacity is an idle capacity (or
utilization) variance – management need to know this and take
corrective action – not try to pass it on to the customer.
26. Standard Costing
Note:
• Built-in continuous management
• Review at completion of Job
• Weekly review of all WIP
• Monthly recon of RM, WIP and FG
27. Kaizen Costing
Std Costing Kaizen Costing
Rates set annually Target Rates set monthly
Rates reviewed Target Rates reviewed
28. Standard = Planned = Budgeted
Basically standard costing uses the planned cost
when accounting for its manufacturing costs.
All deviations from these plans are accounted for
as Variances.
Variances occur for reasons – which are analyzed
(determined) so that we know the reason for the
costs not going according to planned (standard)
costs
Before we start there is a saying - “anyone can get sales at suicide prices”
Ultimately it is what matters to a customer.
Heard from the cockpit on the launch pad – “You realize his craft was built by the lower priced contractor?”
Costing starts at the concept stage – even before the design stage but design is very important to the costs of the final product
The goal is information. Data may be fairly easy to collect – but collation, summary and interpretation is often difficult but critical
It is NO USE AT ALL if the end product is outside the customer’s budget. So working with the customer is of paramount importance.
The starting parameters form boundaries that need to be adhered to.
During our discussions you will hear the word ‘allocated’ and feel that it is easy to manipulate – the answer is that ‘it depends’
Customer satisfaction is attainable only if the customer is reasonable and knowing when to say NO or withdraw is crucial to our own success
The crux (bottom line – no pun intended) is that the cost decisions and model/system will influence the results – which will have dire/important consequences for us all
Without knowledge of costs, you are making decisions blind!
While a price is set by influences of the market, it is important to have some idea of what that sale will cost.
In fact, my personal opinion is that a direct cost can be defined as a charge that does not take place unless the sale takes place.
There are many other costs and expenses that a company has to have a basis of making decisions and measuring profit.
It takes true understanding to be able to make the more difficult of the required decisions about the minimum price that you could charge
especially when price depends on specific negotiations with a customer.
Research, design, development and operations production costs are information that is crucial when seeking to understand what is happening in the real world.
Unfortunately, misinformation is both rife and damaging – it results in wrong decisions that can influence even the continued existence of a company
In a simple situation costs are easily identified and applied.
As soon as there is any complexity, costs are hard to calculate, are easily wrong, misapplied and result in information that is misleading
Costs are usually the result of a policy decision – for example the allocation of a overhead cost is an attempt for a specific sale to bear the burden of its share of that overhead.
Perhaps it could be argued that if the manufacture of that job does not cause the overhead to rise (EG Rent) then the marginal cost is zero.
Therefore the minimum burden the project can bear is zero. BUT should it bear part of the rent?
Of course the bearing of a fair share of the costs and expenses, allocated on a reasonable basis and consistently applied is the grail situation.
However, in individual cases a sale does not even have to recognize costs that are not directly applicable – special circumstance are always applicable.
While exceptions can be made, a company cannot survive if it consistently does not cover its costs and make a contribution to overheads and profit.
The situation where overheads are covered by the planned contribution is called the Breakeven point or volume.
In the overall picture this is a zero profit volume – it has to be attained or there is no profit
Robert Kaplan is regarded as the founder of the theoretical principles of activity based costing within the cost-management knowledge area.
In the 1970s the activity based costing method was introduced in the manufacturing industry to solve problems in traditional cost calculations.
Activity-based costing (ABC) aims to provide a more accurate method of product/service costing, hopefully leading to more accurate pricing decisions. ...
ABC enables ‘better’ ways of allocating and eliminating overheads and improved product and customer profitability analysis.
There are five steps as follows:
1. Identify costly activities required to complete products.
2. Assign overhead costs to the activities identified in step 1.
3. Identify the cost driver for each activity.
4. Calculate an overhead rate for each activity – based on capacity not production
5. Allocate overhead costs to products.
Activity-based costing attempts to overcome the perceived deficiencies in traditional costing methods by more closely aligning activities with products.
This requires abandoning the traditional division between product and period costs, instead seeking to find a more direct linkage between activities, costs, and products.
This means that products will be charged with both the costs of manufacturing and nonmanufacturing activities.
But it also means that some manufacturing costs will not be attached to products.
This is quite a departure from traditional thought.
With ABC a product is only charged with the cost of capacity utilized at a rate calculated ito capacity - Idle capacity is isolated and not charged to a product or service.
Under traditional approaches, idle capacity is incorporated into the overhead allocation rates, thereby potentially distorting the cost of the specific output.
This may limit the ability of managers to truly understand and identify the best business decisions about product pricing and targeted production levels.
Product profitability is portrayed differently under alternative costing methods.
Traditional costing >> applied overhead based on direct labor, is a small portion of the environment.
The point is that skill is required to interpret any costing information and it is all a matter of opinion at the end of the day